Why I'd Stay Away From Navistar

This one's not for the fainthearted. Navistar International's (NYS: NAV) stock spiked nearly 16% in a single day last week, but gave up almost all gains within two trading days.

I had earlier written about the two major concerns on Navistar's hands: warranty claims and compliance issues. The problems have assumed enormous proportions now, raising serious doubts about management's capabilities.

Tough luck
A bit of Navistar good luck, in the form of an EPA rule that allowed the company to sell non-compliant engines if it paid fines, has hit a wall after a federal appeals court struck the rule down. The company had earlier been using pollution credits earned between 2007 and 2009 to keep emissions within limits. The credits expired recently, following which the EPA allowed it to sell engines by paying a non-compliance fine (which ran to about $2,000 per engine).

Peers didn't like it. Cummins (NYS: CMI) and European truck majors Volvo and Daimler challenged the EPA's fine rule. While they had spent millions to comply with the standards, Navistar could bypass those using credits and fines. The court's decision is a victory for these companies, and a blow to Navistar.

Losing balance
It's a make-or-break situation for Navistar. Either it gets its engines certified, or it switches to a nitrogen-oxide elimination technology other industry players have adopted. Neither option is easy. The first one is time-consuming. As an example, Navistar submitted its 13-liter engines for review in January, but has yet to get the certification. The delay has raised doubts about whether the engines meet standards. Others, like the 15-liter ones, haven't even been sent yet.

The second option is tougher, because Navistar might have to stop production to get the new technology in place. And that would mean huge losses.

Warranty woes
If the compliance problem weren't enough, Navistar is battling heavy warranty claims. They dragged the first-quarter bottom line into the red, overshadowing the 11% rise in revenue. Investors were in for a rude shock when the company's claims of warranty repairs peaking turned out to be false. They rose again in the second quarter, leading to losses.

Engines built in 2010 turned out to be faulty. True, meeting the EPA emission standards might have been a difficult task, but considering peer Cummins pulled it off almost flawlessly, I can only say that Navistar did a poor job. Cummins' engines haven't spurred warranty claims. The fact that Cummins' warranty costs hit a 15-year low last year added insult to injury.

Faulty products are a big blow to a company's image. Navistar needs to fix these issues in a way that's cost-effective while retaining customer confidence. Sadly, I don't see an end to the company's warranty woes soon. Neither does the company, which is why it has increased its warranty reserve.

Anything but impressive
There are too many issues with Navistar currently, and as Fool colleague Sean Williams rightly pointed out, management has given investors enough reasons to be miffed.

Why wouldn't an investor consider Cummins or PACCAR (NAS: PCAR) instead? Both companies reported solid results in their last quarters. PACCAR's truck sales are rising at a rapid pace, and might soon give Navistar's brands a run for their money. The latest setback for Navistar only makes things sunnier for peers. Even from a financial standpoint, Navistar scores low. Here are some metrics that will give you an idea.
















Source: S&P Capital IQ. $ in millions. NM = not meaningful because of negative equity.

Navistar's total equity runs into the negative, and its debt load is huge. Negative cash flows and extremely low operating margins make things worse. Standard & Poor's even downgraded the company's rating to four levels below investment grade recently.

The Foolish bottom line
The only factor that could work in Navistar's favor is speculation. Billionaire activist Carl Icahn is raising his stake in the company, and even tried to merge it with Oshkosh some time back. Then there are rumors of European truckmakers showing some interest in taking over Navistar.

Whatever the case, there's just too much uncertainty for me to be excited at a pullback in Navistar's shares. What do you think? Add your comments in the box below. And if Navistar's ups and downs excite you, add the stock to your watchlist to stay updated. Click here to do it.

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At the time thisarticle was published Neha Chamariadoes not own shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of PACCAR and Cummins. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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